Putting the Hog:Corn Ratio in Context

The hog:corn price ratio, almost certainly the longest-standing measure of industry profitability, has been awful for a very, very long time.

The hog:corn price ratio, almost certainly the longest-standing measure of industry profitability, has been awful for a very, very long time. In fact, it has been below 20 – the historical dividing line between profits and losses for the pork industry – for 158 straight weeks. And there are few, if any, prospects of it returning to that level soon. Even next summer’s $70-plus Lean Hogs futures prices will not do the trick with corn well above $3/bu.

So, is this tried and true tool for measuring economic well-being and, therefore, predicting turning points in the U.S. breeding herd still useful? That’s a pretty good question that really boils down to putting the ratio in a modern context. But before we consider that, let’s “study our history,” as President Harry Truman so famously admonished.

First, the hog:corn price ratio is simply the price of market hogs in dollars per hundred pounds live (i.e. $/cwt. live) divided by the price of corn in dollars per bushel. So, $50/cwt. live hogs and $2.50/bu. corn puts the hog:corn ratio at 25:1; $60/cwt. live hogs and $3/bu. corn means the ratio is 20:1. As a statement of the output price in terms of the major production input, the ratio is a proxy measure of profitability.

Figure 1 shows the weekly hog:corn price ratio since 1983. I have inserted a line corresponding to a 20:1 ratio and 0% year-on-year change in pork production. Note that when the ratio has gone above 20:1, year-on-year production has gone above zero two to three years hence. When it broke below the 20:1 level, production went below year-earlier level two to three years hence.

I use past tense in the previous paragraph because the relationship has not been nearly as strong in recent years. The ratio went above 20 in mid-2004, even though production had been higher than year-ago levels for the better part of three years. The reason? The low-carbohydrate, high protein (i.e. Atkins) diet kick of 2004 that drove meat demand sharply higher for a time.

In addition, notice that the year-on-year production line has spent scant time below zero since 2000. The industry was in a slow-but-steady growth pattern for a long, long time and it had no lasting negative impact on profitability from 2004 onward – until late-2006, when corn prices began to rise.

The almost identical patterns of the hog:corn ratio in 1999-2002 and 2004-2006 suggest that the dip to 11:1 in the fall of 2006 would very likely have been short-lived. Normal reactions and production efficiencies would have driven hog prices higher in 2007, possibly covering higher corn prices that did not stay above $4/bu. until December 2007.

But production efficiencies were anything but normal in late 2007, when pigs that had been vaccinated for porcine circovirus began hitting the market. The Q4-’07 slaughter that was nearly 8% larger (with some weekly pork output levels more than 14% larger) than one year before kept hog prices lower than they otherwise would have been the case. When combined with still-rising corn prices, the hog:corn ration was pushed to near-record low levels in early 2008.

That reduction in profitability did, in fact, result in lower pork production earlier this year. So why did it not stay lower and thus drive hog prices and the ratio higher this year? I think the answer is that sometimes pork producers are smart, but the sometimes that intelligence leads them to fool themselves.

Back in 1997, pork production increased as if the hog:corn ratio plunge of 1995-1996 had never taken place. Hog prices were near record-high levels in the summer of 1996, even though the hog:corn ratio was only in the 12-14 range due to corn prices that reached $4.91/bu. in Omaha the week of Aug. 22, 1996. The production line suggests, though, that pork producers knew the high corn prices were a one-shot anomaly and kept up with their expansion plans.

Possible Illusions So what about last year? It appears to me that we fooled ourselves on possibly two counts. The first, which I believe is unlikely, is the idea that corn prices would fall enough to return to “normal.” While it was true they would fall, it was never in the cards for a return to price levels we had known. I don’t think that is a possibility until corn yields have enough time to increase 10-20%. At 2-3% per year, that will take awhile.

The second possible trap was thinking that 2008’s exports were the new baseline from which we would work in the future. I heard talk of that at several meetings last year and I think this may have actually caught on with some producers. Those who bought into the idea probably made little or no change in their breeding herds, meaning that the output reduction slowed. Continuing gains in productivity and an exceptionally cool summer caused the year-on-year reductions to actually turn into year-on-year gains in all but three weeks since July 4.

Is Hog:Corn Ratio Still Useful? Right now the answer may be no. The reason is that we are in a huge structural adjustment to higher costs. I think we are going to find that 20:1 (or something very near that level) will someday again be a useful barometer for predicting production changes 2-3 years hence, but it may take two more years for that to happen.

I also think that the ratio will provide a guide, but that some thought must be applied to make it useful. That has really always been the case, but it may be even truer in future years when the more volatile markets that virtually everyone expects will cause “rules of thumb” to be, first, more like “suggestions of thumb” and second, to be fleeting suggestions at best.